Orthopaedic Supplier M&A Boosted by Private Equity Backing

Supplier companies have been involved in 17 of the 33 mergers and acquisitions that have closed in the orthopaedic space as of August 15, according to our tracking of activity.

Supplier M&A activity is a direct response to device company consolidation and desire for one-stop-shop supplier partners that can offer breadth of capability, capacity and geographic reach, while keeping costs in check. A portion of that supplier activity is being funded by private equity firms that seek to combine their strengths in manufacturing and bolt-on acquisitions to capitalize on orthopaedics’ transition to a less-fragmented industry.

Private equity support in 2017 has included Avalign’s acquisitions of Thortex and Millennium Surgical (Avalign is owned by Arlington Capital Partners); Charlesbank Capital Partners’ repurchase of Tecomet after divesting the company to Genstar Capital Management in 2013 and ARCH Global Precision’s purchase of Seabrook International. (ARCH Global Precision was founded in 2011 by Strength Capital Partners.) Upon completion of the Seabrook transaction, ARCH Medical Solutions was formalized to include Seabrook and ARCH orthopaedic contract manufacturers Advanced Precision and Bob Mfg.

These are just three examples. In’Tech Medical (TCR Capital), Orchid Orthopedic Solutions (Altor) and Paragon Medical (Beecken Petty O’Keefe & Company), three companies engaged in multiple acquisitions in recent years, are private equity portfolio companies. And in 2016, Medin (Seven Point Equity Partners) and MedPlast (Water Street Healthcare, JLL Partners) were acquired by private equity firms.

Record fundraising coupled with an attractive lending environment is expected to increase supplier M&A activity for the foreseeable future, says Jack Serda, who is on assignment for Strength Capital Partners as Vice President of Corporate Development, ARCH Global Precision. Exit multiples for leading contract manufacturers remain attractive, given the execution of the right consolidation strategy, allowing ample opportunity for investors to receive above-market returns.

“As the OEMs continue to select ‘winners and losers’ throughout their respective supply bases, the positive long-term outlook for these top suppliers represent a compelling investment opportunity,” Serda says.

Robert Kinsella, Founder and President of Kinsella Group, a boutique investment bank and business advisory group, expects the current M&A pace on the supplier side to continue for at least the next two years, possibly longer if viable candidates are available. Kinsella Group advised in Seven Point’s purchase of Medin and Avalign’s purchase of Thortex.

Kinsella says that today’s private equity investors are interested in growing supplier businesses as opposed to the previous model of cutting expenses, limiting CapEx and then exiting quickly.

“The result will be stronger, larger, more profitable suppliers over time,” Kinsella says. “Additionally, the supplier sector will become more international, with more businesses having a presence in North America as well as Europe (and the U.K.) and in time, Eastern Europe.”

What does this M&A trend mean for suppliers, specifically?

Serda: In order to keep up with the rate of expansion of outsourced orthopaedic products, smaller to mid-sized contract manufacturers will be forced to either join forces with others or invest heavily in organic growth.

Kinsella: For second- and third-tier suppliers, it’s a great time to sell. But sellers should recognize that valuations will be much higher from industry participants than private equity (PE) firms new to the sector. There are many PEs seeking lower middle market companies (EBIDTA $2MM-$6MM), but most will not be comfortable with industry multiples and customer concentrations. Lots of time and effort can be wasted responding to overtures from PEs new to the sector.

Experienced sector acquirers seem to be willing to pay market rates for well run, profitable businesses. They don’t seem to look for “bargains,” but rather quality businesses for which a full price is paid. Most acquirers don’t seem to have much interest in temperamental owners, or companies with poor profitability despite a below-market price. In other words, we are not seeing much interest in “fixer uppers” in this sector. Well-represented companies whose finances are in order, that can promise management continuity and make a clear presentation of capabilities and potential, will find knowledgeable buyers willing to pay a market price.

What does supplier M&A activity mean for device companies?

Serda: The larger OEMs will continue to shift away from using smaller suppliers. Once a supplier is chosen for a new program, there is a longer-term commitment implied by that selection. OEMs are forced to invest heavily in the manufacturing qualification process and will need to be assured that the supplier(s) can handle not only the initial market launch in rapid form, but any potential increase in demand associated with a positive product response received by the market.

Smaller OEMs will also be impacted by the narrowing of options among suppliers as they work to join others in pursuit of larger-scale opportunities. The demand for safe and effective products for orthopaedic procedures continues to increase, as does the theme of outsourcing, particularly for products that are more difficult to manufacture and are specialized in nature. Generally speaking, earlier stage device developers utilize smaller, less-mature suppliers, as they are capable manufacturers that can be more flexible and responsive due to fewer process/manufacturing controls.

As consolidation at the supplier base continues, the need for harmonized but efficient manufacturing, process and quality control measures will need to be developed. Close collaboration and exercising the true meaning of the term “partnership” will define success of such initiatives. As contract manufacturers grow, they need to retain their ability to be nimble, which is a key element in their ability to support second-tier OEMs. Many of the smaller, market-challenging OEMs will eventually develop into sizable sales channels as they grow organically or are consumed by top-tier OEMs.

Kinsella: Smaller device companies may over time find that their suppliers have been acquired by larger suppliers that may be less responsive to smaller device company customers. Large device companies will find that their supply base will be smaller. Whether this leads to lower costs overall for the big OEM customers is yet to be seen.

While orthopaedics faces cost pressures and regulations, the interest in private equity firms reinforces what’s attractive about the industry: demographics, emerging markets, longer product life cycles and barriers to entry. Well-integrated, more profitable supplier companies are expected to emerge from these investments, ready to meet the demands of consolidating device companies and their consolidating hospital customers.

Who and What in 2017 Supplier M&A

Nearly 52% of the mergers and acquisitions that took place from January to August 15, 2017 involved a supplier. The majority of activities involved suppliers purchasing suppliers in order to expand capabilities. Here we present a list of those transactions and how the acquirer benefits.